Thursday, December 11, 2008

China struggles with sinking world prices

As global commodity prices sink, China is struggling to support domestic prices, keep farm incomes from falling and preserve incentives to plant grain next year.

Chinese corn demand is nearly stagnant as the livestock sector slows down. There is another surplus of pork and demand for milk and eggs has collapsed after the melamine incident.

Meanwhile, China has had its fifth consecutive big grain harvest and now is cursed with a flood of grain that has little demand. Prices are on the way down, and farmers are keeping their grain in storage to see if prices get better later.

The government has upped its purchases of corn and soybeans, but what does it do with all this grain in "temporary" reserves? In past years the government subsidized exports of surplus corn or turned it into ethanol. These ideas are being floated again. There is a rumor that an export quota of 5 mmt will be approved. Trouble is, Chinese corn is now much more expensive than corn on the world market. In pre-WTO days, the government just paid a subsidy to the exporters but WTO disallows export subsidies. Now a "VAT rebate" of 13% is given instead, but even with the rebate Chinese corn still couldn't match competitors' prices. In fact, U.S. corn would be competitive in the China market if it were let in. According to an article on finance.sina.com.cn the corn price in southern China ports is 1600 yuan/mt, but the estimated delivered price of U.S. corn in southern China is only 1200 yuan/mt, 25% less. A Reuters news report noted that South Korean buyers purchased U.S. corn at $155/mt the other day, the equivalent of less than 1100 yuan/mt.

Another proposal considered in the finance.sina.com.cn article is to make the surplus corn into ethanol to burn as fuel. This is how China's ethanol industry was birthed in the early 2000's--to literally burn up surplus corn. However, the article notes that ethanol prices are already well below costs of production and this route would require big subsidies, so this is a nonstarter.

The current market environment is putting China's commitment to free trade to the test. According to Reuters, imported corn is attractive to Chinese feed mills but no one dares to try importing at the risk of attracting the government's ire. The tariff rate quota system set up after China's WTO accession in theory allows a set amount of corn to be imported at a 1% tariff each year, but hardly any has ever been imported. The price differential and high shipping rates didn't favor imported corn imports until now. Potential buyers quoted by Reuters say that they are afraid shipments of corn imports would be caught up in testing and approvals at the border to comply with China's intentionally vague genetically modified food regulations.

Meanwhile, the soybean market is even more of a mess. Since domestic soybeans are more expensive than imports no one wants to buy domestic beans except the government. Many people in the industry favor raising the tariff on soybean imports, but China is again constrained by its WTO commitment to cap its soybean tariff at 3%.

It would not be surprising if Chinese quarantine inspectors find some kind of fungus, pest, or contamination in soybean shipments arriving in China very soon.